Chapter 12: regulations

Question 1

SEC

Answer 1

– Responsible for supervision of capital markets
– writes and enforces laws.
– governs publicly traded companies and industry professionals.
– can revoke the registration of a broker dealer
– refers criminal cases to the judicial system.
– involve OTC and exchange secondary markets, regulates the SROs and supervises their enforcement responsibilities.

The President of the United States appoints SEC board members for five years. Advice and consent from the senate.

Question 2

FINRA

Answer 2

The Securities Exchange Act of 1934 was established to regulate the trading of securities after they have been issued (secondary market) and to regulate exchanges and broker/dealers. When the National Association of Securities Dealers (currently FINRA) was formed, the SEC received the authority to review FINRA disciplinary actions, disapprove rulings and suspend or revoke registration for failure to comply with its rules.

Question 3

The four categories of FINRA rules

Answer 3

– The uniform practice code.
– the conduct rules
– the code of procedure.
– the code of arbitration.

Question 4

The uniform practice code

Answer 4

Relates to dealings between member firms, covering all transactions in non-exempt securities, while providing orderly completion of dealer to dealer transactions

These rules establish standard industry practice for procedures such as regular way trade settlement, confirmation delivery, filing of forms such as U4, U5, and Form BD. There are also rules establishing the qualifications and registration requirements of members. Any broker/dealer who is authorized to transact securities business in the United States is eligible for FINRA membership, except those who have been suspended or barred from membership due to securities violations.

Personnel of FINRA members are required to be qualified with respect to both training and experience under the UPC. It is important to understand that the UPC addresses broker/dealer interaction with one another as well as associated persons. The two registration categories of FINRA personnel are principals and representatives. Both categories require FINRA registration and the passing of a qualifying examination. Any member who has passed a qualifying examination and later terminates registration is required to pass the examination again if the termination is for a period of 2 years or longer.

Question 5

Conduct rules

Answer 5

Relate to a member firms dealings with the public

Question 6

Code of procedure

Answer 6

Outlines the procedural process in the event of violations and complaints. A customer with a complaint against a member firm or its personnel may submit a written complaint to any Department of Enforcement (DOE). The Board of Governors may also file a complaint with the Department of Enforcement. The Department of Enforcement has the initial jurisdiction for the handling of complaints. The National Adjudicatory Council (NAC) has appellate and review jurisdiction.

The broker/dealer must keep a file of written customer complaints. A report of these complaints must be submitted to FINRA each calendar quarter, no later than the last day of the month following the quarter’s end. If a complaint results in a statutory disqualification, a report must be sent to FINRA within 10 business days. Additionally, if the firm has assessed internal disciplinary measures in the amount of $2,500 or more, this information must be filed with FINRA.

The Code of Procedure deals with discipline of a representative, principal, or firm. The civil (money) part of disputes is a separate process called Code of Arbitration. FINRA itself, the SEC, or a customer can initiate a complaint.

When a written customer complaint has been received, the Department of Enforcement starts the process by advising representatives and broker/dealers in writing, and conducts hearings to gather enough facts to make a fair decision. After the hearing, the Department of Enforcement will make a written decision. If the decision is that a violation has occurred, a censure or fine may result. For more serious violations, a suspension, expulsion, or bar from association with a member firm may be imposed. FINRA registration may also be revoked.

A person that has been suspended may not be associated with a member firm in any capacity, including clerical. Suspended persons cannot be compensated in any manner, including remuneration from securities transactions, during the period of suspension.

Appeals of Department of Enforcement decisions go to the National Adjudicatory Council, then to the SEC, then to the courts.

Alternatively, if FINRA and the respondent agree, a penalty may be imposed through acceptance, waiver and consent (similar to plea bargaining). This AWC process is only available if the respondent does not dispute the allegations in the complaint, and waives the right to a hearing and the right to an appeal. If the AWC letter is not accepted, the matter will be pursued normally under the Code.

For less serious violations, usually of an administrative nature, a Minor Rule Violation procedure will apply with a maximum fine of $2,500 with no appeals. If this summary complaint procedure is offered, the respondent has 10 business days to accept it. By signing the minor rule violation letter (MRV) the respondent gives up the right to appeal the decision. Should the summary complaint procedure not be accepted, the Department of Enforcement will proceed with a formal hearing under the Code of Procedure.

If the Department of Enforcement does not find grounds to pursue a complaint, the dismissal of the complaint will also be provided in writing.

Question 7

Code of arbitration

Answer 7

The purpose of arbitration is to settle inter-industry disputes. For example, one member firm against another, or against a bank, or a transfer agent. Arbitration is an alternative to litigation and mediation. Arbitration provides a cost-effective method through which disputes are typically settled much sooner than they would be if pursued through the courts.

The Code of Arbitration instructs that the following disputes be submitted to arbitration:

-Between or among members; and
-Between or among members and associated persons.
-A customer seeking monetary damages may also go to arbitration, but the customer must first agree to use arbitration as a means of settlement. Customers normally agree to arbitration as part of the process of opening their accounts. There are no appeals to arbitration.

The statute of limitations for a submission to arbitration is 6 years after the event giving rise to the claim.

The National Arbitration Committee appoints a panel of arbitrators to hear a dispute. The panel includes arbitrators from both the public and investment industry sectors and consists of an odd number of 1, 3 or possibly 5 members.

The arbitrators hear the evidence of the dispute and make their determination for awards and settlements as deemed appropriate. Unless the law instructs differently, the decision of the arbitrators is final and binding on both members and customers.

For disputes involving amounts of $50,000 or less, simplified arbitration is available. Under this proceeding, there is no opportunity for a hearing. One arbitrator renders a decision on the case based upon a review of written submissions by both parties.

Awards under arbitration are final and binding without opportunity for appeal. Any resulting monetary award is required to be paid within 30 days. If a member firm or registered rep fails to pay an award under arbitration, they are subject to suspension.

All awards must be honored by a cash payment in the exact dollar amount stated in the award, unless stated otherwise and agreed by the parties in writing.

Question 8

Definition - associated person

Answer 8

The Uniform Practice Code By-Laws define a registered broker/dealer as a firm who is registered with the Commission under the Act of ‘34. It further defines an associated person as

-An individual registered under the rules of FINRA; or
-An individual who is directly or indirectly controlled by a member firm, regardless if the person is registered

Question 9

Maintaining Qualifications Program (MQP)

Answer 9

Registered persons who terminate any representative or principal registration category, including any permissive registration category, have the option of maintaining their qualification for the terminated registration category beyond the current 2-year qualification period by completing annual CE through a new program called the Maintaining Qualifications Program.

MQP participants will have a maximum of 5 years following the termination of a representative or principal registration category to reregister without having to requalify by examination or having to obtain an examination waiver.

The following are the conditions for eligibility and participation in the MQP:

-Individuals must have been registered in the terminated registration category for at least 1 year immediately prior to the termination and must not have been subject to a statutory disqualification during that one-year registration period.
-Individuals must make their election to participate in the MQP at the time of their Form U5 submission or within 2 years from the termination of a registration category.
-Individuals must not have been subject to a statutory disqualification between the date of their Form U5 submission and the date they make their election to participate in the MQP.

The MQP option is not available to individuals who have passed the Securities Industry Essentials (SIE) examination only.

Question 10

Registered principals

Answer 10

Persons associated with a member who are actively engaged in the management of the member’s securities business, including supervision, solicitation or the training of persons associated with a member, must be registered as principals. The following persons are included in the definition:

-Sole proprietors;
-Officers;
-Partner;
-Managers of Offices of Supervisory Jurisdiction; and
Directors of corporations.

A principal may register as a Limited Principal - Investment Company and Variable Contracts if activities are limited to dealings of shares of open-end investment companies, closed-end investment companies during the IPO only, and variable contracts and insurance premium funding programs.

Persons falling under this definition must pass the Limited Principal - Investment Company and Variable Products Qualification Examination (Series 26)

Question 11

Registered person requirements

Answer 11

Any person associated with a member firm that is engaged in the investment banking or securities business must be registered. The process is started through the filing of a U-4 form, which requires personal information, 5 years of address information and 10 years of employment history. Persons whose activities are limited solely to investment company shares and variable contracts may seek a limited registration by passing an Investment Company Product/Variable Contract Limited Representative examination (Series 6) or the General Securities Representative examination (Series 7). Please note that registered representatives with Series 6 limited registrations can only sell closed-end investment companies during the initial offering. A Series 7 license is required to sell closed-end companies shares in the secondary markets.

Persons who are to be registered must submit fingerprints as part of the registration process. The requirement applies to all partners, directors, officers and employees of all persons associated with the broker/dealer.

Industry employees who do not require fingerprinting are persons who are not engaged in the sale of securities, or do not regularly have access to the keeping, handling or processing of securities, money, or original books and records relating to securities or money. Certain firm personnel that handle money and are not registered may still require fingerprinting.

Question 12

Continuing education - Regulatory Element

Answer 12

Regulatory Element,*** under an amendment to FINRA Rule 1240, must be completed by registered persons annually by December 31 for each representative or principal registration they hold. FINRA has customized the Regulatory Element content so that it is specific to each registration category.

The initial annual Regulatory Element is due by December 31, 2023 for individuals whose registration has not changed after January 1, 2023, and for individuals who reregister or passed an exam in 2023. However, for those individuals who register for the first time in 2023 or who reregister in 2023 after completing the Regulatory Element in 2023 or passed an examination in that examination category, the due date is December 31, 2024.

Any registered persons who have not completed the Regulatory Element within the prescribed time frames will have their registration deemed CE inactive until the requirements have been met. Any person whose registration has been deemed inactive under this rule must cease all activities as a registered person and is prohibited from performing any duties and functioning in any capacity requiring registration.

***Prior to January 1, 2023, the CE requirement for the Regulatory Element was as follows: “The Regulatory Element must be completed by each registered person on the second anniversary date of their registration and every 3 years thereafter. They have 120 days from the second anniversary of their initial registration date for completion.”

Question 13

Continuing education - Firm Element

Answer 13

Firm Element applies to a continuing and current education program maintained by members for all registered persons on topics related to the role, activities, and responsibilities of the registered person and to their professional responsibility. At a minimum, each member must evaluate and prioritize its training needs and develop a written training plan at least annually. Firms may use a variety of educational programs to satisfy firm element training, including in person and in online training events offered by outside vendors.

If a registered representative is called to active military duty, the representative’s registration is put on special inactive status. During this freeze, if the representative is in the 120-day window to complete continuing education, the window is frozen. The representative may continue to receive commissions from existing clients. If the representative terminates registration while on leave, the representative has 90 days to re-associate with a new employer before the 2-year time limit begins.

Question 14

Voluntary termination of registered representatives

Answer 14

Registered representatives may voluntarily terminate FINRA registration at any time by written notice (Form U5). The Form U5 must be filed by the member firm through the CRD within 30 days of termination. In addition, the firm must forward a copy to the terminated representative. If a registered representative secures a new job with a different broker/dealer, the previous broker/dealer has no responsibility to give a copy of the Form U5 to the new broker/dealer. The new broker/dealer can receive a copy through the CRD or ask the applicant for a copy. If the new broker/dealer requests a copy of the Form U5 from the applicant, the applicant must provide it within 2 business days. Registered representatives and associated persons terminating registration are still under the jurisdiction of FINRA, and subject to any complaint filings for 2 years following the termination.

In addition, FINRA retains jurisdiction for a member firm that resigns or has had its membership canceled or revoked. The firm must file any customer complaints based on conduct that commenced prior to the effective date of the member’s resignation from FINRA or the cancellation or revocation of its FINRA membership. The complaint must be filed within 2 years after the effective date of the resignation, cancellation, or revocation.

Question 15

Persons not requiring FINRA registration

Answer 15

-Those whose sole functions are limited to clerical or ministerial duties;
-Not actively engaged in the investment banking or securities business;
-Associated persons of member firms whose only participation within the firm is the need for a nominal corporate officer or for capital participation;
-Those who effect securities transactions only on the floor of an exchange, only transact exempt securities or only transact commodity futures transactions.

Question 16

Broker-dealer disqualification

Answer 16

-Broker/dealers who have been suspended or expelled from a registered national securities association or national securities exchange;
-Broker/dealers who have been barred or suspended for conduct inconsistent with just and equitable trade practices; and
-Broker/dealer enjoined by a court from engaging as investment advisers, underwriters, brokers, dealers, or in any other capacity in connection with the securities business.

Question 17

Statutory disqualification

Answer 17

Any person who has been convicted within the past 10 years of application for registration of a felony or a securities related misdemeanor may be subject to disqualification. Persons may also be barred from performing duties of a registered representative because of prohibited practices and other violations of Conduct Rules.

Question 18

Other Broker-dealer representation rules

Answer 18

Member firms cannot represent FINRA membership in a way that would suggest that they are endorsed by the Authority. For example, it is acceptable to use the term “Member of FINRA” in advertising and letterheads, but there are rules concerning its over-emphasis by the use of large type size, etc.

If a broker/dealer conducts business in an office inside a bank, the broker/dealer must be clearly delineated with separate identification.

Customers must also be notified that the broker/dealer offers security products which are not FDIC-insured and are not bank obligations. The broker/dealer must attempt to get written acknowledgement from the customer that such disclosure has been made. However, the customer is not required to provide written acknowledgement, and the broker/dealer may conduct business with such noncompliant customers.

Question 19

Form U4

Answer 19

-Name;
-Social Security number;
-Physical characteristics;
-Past residential addresses (for the previous 5 years);
-Employment history (for the previous 10 years);
-Financial history relative to bankruptcy (for the previous 10 years);
-Unsatisfied liens; and
-Any disciplinary history (if applicable), such as any felony convictions, and misdemeanors that involve securities or theft, forgery or embezzlement. If the respondent answers yes to any of these disclosure questions, an explanation must be provided on the disclosure reporting page (DRP) and be sent with the U4 Form for review by FINRA.

Form U4 information is stored in FINRA’s Central Registration Depository (CRD) database. Any changes to Form U4 information must be updated in 30 days.

All candidates for registration must submit fingerprints as part of the registration process. The fingerprinting requirement is also extended to persons that have access to processing transactions and handling of securities, money, or firm financial records, whether or not they are registered.

Question 20

FINRA rule 1122

Answer 20

According to FINRA Rule 1122 - Filing of Misleading Information as to Membership or Registration, members or associated persons cannot file membership and registration information that is misleading, or fail to correct misleading information once informed of it. According to FINRA, misleading information is information that is incomplete or inaccurate to the point of being misleading or intending to mislead.

Filing false, inaccurate and/or misleading information may result in statutory disqualification, which, in turn, may prevent a person from becoming registered, or can result in a revocation of registered status.

Question 21

Supervision of registered representatives

Answer 21

A member’s supervisory system must provide, at a minimum, for the following:

-Establishing and maintaining written procedures;
-Designation of an appropriately registered principal(s) with authority to carry out the supervisory responsibilities of the member for each type of business in which it engages for which registration as a broker/dealer is required (i.e. One person to oversee each department).
-Designation as an office of supervisory jurisdiction (OSJ) of each location;
-Designation of one or more appropriately registered principals in each OSJ, including the main office, and one or more appropriately registered representatives or principals in each non-OSJ branch office with authority to carry out the supervisory responsibilities assigned to that office by the member;
-Assignment of each registered person to an appropriately registered representative and/or principal for his/her supervision;
-Reasonable efforts to determine that all supervisory personnel are qualified by virtue of experience or training to carry out their assigned responsibilities;
-Participation of each registered representative, at least annually, in an interview or meeting conducted by persons designated by the member at which compliance matters relevant to the activities of the representative(s) are discussed (this meeting can be held live or delivered electronically as long as attendance can be verified); and
-Each member must designate and specifically identify to FINRA one or more principals who will review the supervisory system, procedures and inspections implemented by the member.

Question 22

BrokerCheck

Answer 22

A free resource provided through FINRA’s Public Disclosure Program that allows public persons to research the professional backgrounds of current and former FINRA-registered brokerage firms and brokers. Accessible by phone or online, it provides information that has been stored in the Central Registration Depository (CRD) as part of the registration process.

Available information includes the following:

-The person’s employment history and other business experience required to be reported on Form U4;
-Currently approved registrations for the member or associated person;
-The main office, legal status and type of business engaged in by the member; and
-Any event or proceeding required to be reported under the Rule.

It is each member’s responsibility to keep in each office of supervisory jurisdiction one of the following:
-A separate file of all written complaints of customers with explanation of action taken by the member, if any; or
-A separate file of all written complaints and a clear reference to the files containing the correspondence related to them (as maintained in the office).

Question 23

Retail communications

Answer 23

Defined as any material used in the media (newspapers, magazines, radio, television, telephone recordings or other public media). Additionally, any promotional communications sent to more than 25 customers or prospects within a 30 calendar-day period are considered to be retail communications.

Question 24

Public appearances

Answer 24

Are included in the definition of retail communications since they are directed at or made available to the public. Public appearances refer to participation in seminars, radio or television interviews, or other public speaking activities.

Question 25

Independently prepared reprints

Answer 25

include any reprint of an article or its excerpt issued by a publisher not affiliated with the member using the reprint, or to any report concerning a registered investment company prepared by an independent entity. Independently prepared reprints are considered retail communications, and must be approved by a principal before first use.

Question 26

Correspondence

Answer 26

refers to any written or e-mail messages distributed to either existing customers or to 25 or fewer prospective customers within any 30 calendar-day period.

While correspondence does not need to be approved by a registered principal prior to use, it is subject to supervision and review requirements; however, the review may be either pre or post.

Specific communications with individuals, internal memorandums, tombstone announcements, routine announcements discussing member firm personnel changes, and prospectuses are excluded from the scope of FINRA approval rule.

Question 27

Testimonial/Endorsement

Answer 27

Any presentation of such testimonial must state all of the following:

-If any fee or other compensation was paid for the testimonial or endorsement;
-If the statement implies that the person is qualified by special experience or knowledge, such qualifications must be listed; and
-Include the statement “past performance does not indicate future results.”

Also, any offer of free services must indeed be furnished entirely free and without conditions or obligations on the part of the respondent. Such offers are prohibited if the respondent must assume any sort of obligation as a result.

Question 28

Filing requirements and review procedures

Answer 28

Prior to use, retail communications, including advertisements, must be approved by a registered principal of the member firm. Member firms that have not previously filed a retail communication must file their initial retail communication with FINRA at least 10 business days prior to use, and must continue to file at least 10 business days prior to use for a period of 1 year. These materials must be kept on file for 3 years, along with the name of the preparing person and the name of the approving person. Required information also includes the sources of any statistical tables, charts, graphs or illustrations used in communications with the public.

Question 29

Institutional sales material - the institutions

Answer 29

Institutional sales material is communication with institutional investors, defined as any

Banks;
Savings and loans associations;
Insurance companies;
Registered investment companies;
Registered investment advisers;
Person or entity with assets of at least $50 million;
Government entities or subdivisions;
Employee benefit plans and qualified plans with at least 100 participants;
FINRA member firms and registered associated persons; and
Persons acting solely on behalf of any institutional investor.

A firm’s internal communications are excluded from the definition of institutional communication.

Question 30

Institutional sales materials

Answer 30

defined as any written or electronic communication that is directed only toward institutional investors, such as banks, thrifts, savings and loans, insurance companies, mutual funds, and other broker/dealers.

Institutional communications are subject to supervision and review by an appropriately qualified registered principal. However, in general, principal approval is not required for institutional communications, prior to first use or distribution, if a firm has written procedures in place for supervising and reviewing these communications. It is the responsibility of each firm to establish written procedures that match its business, size, structure, and customers for the review of institutional communications by a principal. If a firm does not require approval prior to first use or distribution, the firm must provide education and training for its associates that address its written procedures for institutional communications.

Note that if the firm has reason to believe that a communication directed to institutional investors will be distributed to retail investors, it must treat the communication as a retail communication, which then would be subject to registered principal approval prior to first use or distribution.

All institutional communications, including the name of the person who prepared each item, must be maintained for a period of 3 years from the date last issued. Included with this filing requirement is information about the sources of any statistical tables, charts, graphs or illustrations used in communications with the public.

All institutional communications, as well as correspondence and retail communications, are subject to a spot check by FINRA for at least 3 years from last use.

Question 31

Private securities transactions

Answer 31

Transaction executed outside the normal business of an associated person’s employment with the member firm. They are not recorded on the firm’s books and records.

“A.k.a. selling away” and is a violation of the FINRA conduct rules.

Exempt: 1) Transactions among immediate family members with no compensation, and 2) personal transactions, and investment company and variable in the way the securities

To do so, associated persons must receive prior written notice to the member form, and must include
-The proposed transaction
– The person’s proposed role
– Compensation conditions

If approved by the member firm, will be recorded on their books and then must supervise the participation in the transaction.

Question 32

Compensation - sources other than the member firm

Answer 32

No member or associated person can accept any compensation in the form of cash, non-cash compensation, securities, payments or gifts from anyone other than the member with which the person is associated unless special arrangements, permissions and recordkeeping are in place. The following non-cash compensation arrangements are permitted:

-Gifts that do not exceed an annual amount of $100 per person and are not preconditioned on achievement of a sales target;
-An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment, which is not frequent or contingent upon a preconditioned sales target;
-Payment or reimbursement for the purpose of training or education of associated persons of a member.

Question 33

Use of Investment Company Rankings in Retail Communications

Answer 33

FINRA prohibits members from using mutual fund rankings in retail communications unless the rankings are created by and published by a ranking entity, or based on performance ratings created by a ranking entity. FINRA defines a ranking entity as an “entity that provides general information about investment companies to the public, that is independent from the investment company and its affiliates, and whose services are not procured by the investment company or any of its affiliates to assign the investment company a ranking.” Ex: Morningstar.

To use investment company rankings in retail communications, members must adhere to FINRA rules listed next. First and foremost, FINRA prohibits the display of a headline or prominent statement that says a fund is a top performing fund in an investment category, unless the statement is true.

In addition, retail communications containing investment company rankings must prominently display the following disclosures:-
-The fund’s investment category (income, growth, balanced);
-The number of investment companies, or, if applicable, investment company families in the category;
-If the investment company itself created the category or subcategory;
-The name of the ranking entity;
-The length of the period being ranked, including the first and last day of the period;
-Ranking criteria (total return, yield, etc.).

Other required disclosures include:
-A statement that past performance is no guarantee of future results;
-Whether or not the ranking has taken loads and sales fees into account;
-The publisher of the ranking (such as a magazine);
-If the ranking is a symbol system (like the star system) and the meaning of the symbols;
-If the ranking is based on total returns or yields that do not include fees and expenses which had a material effect on the return or yield during the ranking period, then there must be a statement to that effect.

In addition, rankings must be current, or at least to the end of the most recent calendar quarter. If the ranking entity does not have a ranking of the most recent quarter, the most current ranking available may be used as long as it is not misleading.

With the exception of money market funds, the following rules apply to time periods for investment company rankings in retail communications:
-Rankings cannot show a time period less than one year (unless it is based on yield);
-Investment companies that have been in existence for one year may show a total return ranking for a 1-year period. Companies in existence for 5 years that show one year of total returns must also show 5 years of total returns. Companies in existence for 10 years that show one year of total returns must also show 5-year and 10-year returns.

Question 34

Bond Mutual Fund Volatility Ratings

Answer 34

FINRA defines a bond mutual fund volatility rating as a report issued by an independent third party that describes the way the price of a bond fund (net asset value) changes in reaction to market conditions and the economy. FINRA further states that a bond fund volatility rating contains an objective analysis of a bond fund’s performance and other considerations like the credit quality of individual bond holdings, interest rate risk, currency risk, prepayment risk, and currency risk, that can affect the value of the portfolio.

When used in retail communications, bond mutual fund volatility ratings must be accompanied or preceded by a prospectus (supplemental sales literature). There must be a disclosure statement that includes all the recent bond mutual fund volatility ratings issued on the fund, the names of the ratings’ issuers, the most current rating, and the date of the rating. If the most current rating has changed, then reasons for the change must be included.

In addition, there must be a description of the rating written in narrative form that includes the following disclosures:
-A statement that no standard method exists for assigning ratings;
-A description of the criteria and methodologies used to ascertain the rating;
-The type of risk that the rating measures (such as long-term volatility or short-term volatility);
-A statement that not all bond funds have volatility ratings, and that the portfolio may have changed since the rating was issued;
-A statement that there is no guarantee that the fund will continue to have the same rating or to performance as it has in the past; and
-Any fee or compensation that was paid for the rating.

In addition, the bond volatility rating must meet the following criteria:-
-The rating must not refer to volatility a “risk rating”
-The supplemental sales literature uses the most up to date ratings available, and the information is current to at least the end of most recent calendar quarter;
-The rating and disclosure statement must be clear, concise and understandable, and based only on factors that are objective and quantifiable;
-The issuer of the rating must provide detailed disclosure of its methodology and make it available to investors through a website, a toll-free number, or both.

Question 35

Maintenance and Retention of Books and Records

Answer 35

The SEC has implemented rules to ensure access to basic information about securities transactions and firms that enable it to adequately supervise the U.S. securities markets. Members must maintain daily blotters containing all purchases and sales of securities as well as company and customer ledgers. Members are also required to retain records. Retention records vary by the type of record.

It is illegal to destroy, mutilate or alter any account, book or other documents that are required to be maintained by the firm.

Books and records may be maintained in print form, or on an electronic recordkeeping system that preserves records in a digital format and permits the records to be viewed and downloaded. The records may be preserved consistent with either the WORM requirement — write-once, read-many (multiple) times — or an alternative audit trail requirement. Information in the WORM format cannot be modified once it is written. If the time-stamped audit trail alternative is used, it must document all modifications and deletions; dates and times; identities of individuals making changes; and any other information necessary to maintain an audit trail in a way that maintains security, signatures, and data to ensure the authenticity and reliability of the record and permits the original record to be recreated if modified or deleted. Any person who has access to or handles books and records must be fingerprinted. Firms can submit fingerprints without registering an individual by completing Form NRF (Non-Registered Fingerprint).

Question 36

SUMMARY OF RECORD RETENTION REQUIREMENTS

Answer 36

TYPE OF RECORD RETENTION REQUIREMENT
Account records - 6 years
Customer complaints - 4 years
Confirmations - 3 years
Retail communications - 3 years
Institutional communications - 3 years
Correspondence - 3 years

Important: for the first 2 years, these records must be kept in an easily accessible place and readily available to regulators upon request.

Question 37

Financial Exploitation of Seniors

Answer 37

Defined as seniors (age 65 or older) and adults age 18 or older who have mental or physical disabilities. Elder abuse takes many forms, but specifically with regard to financial exploitation, warning signs may include:

-Inappropriate financial products and services;
-Unusual or erratic transactions;
-Frequent, large withdrawals;
-Selling investments or closing accounts without regard to the penalties;
-Large wire transactions out of the account that are not characteristic of past activity; and
-Sudden change in beneficiaries or appointment of a Power of Attorney.

In addition, behavioral changes and signs of confusion or fearfulness may be indicative of elder abuse. A senior individual may be unfamiliar with an account or investment, or may not want to discuss their financial situation. The individual is not available by phone and when seen in person is always accompanied by a caretaker or relative; this person may speak on behalf of the individual or exhibit excessive interest in the senior’s financial affairs.

FINRA permits member firms that suspect financial exploitation of seniors and other adults who have mental or physical disabilities to place a temporary hold on the disbursement of funds or securities from the customer’s account. The temporary hold is authorized for 15 business days, but could be extended for another 10 days if warranted. In addition, members are required to make reasonable efforts to obtain the name and contact information of a trusted contact person for a customer’s account. At the time of account opening and when updating account information, the member firm must provide written disclosure to the customer that it is authorized to contact the trusted contact person and disclose information about the customer’s account. If a hold is placed on the account, the member firm is required to provide notification of, and the reason for, the hold to the trusted contact person and the customer within 2 business days of the hold. (FINRA Rule 2165)

Question 38

Customer Complaints Involving Theft, Misappropriations of Fund or Securities, or Forgery

Answer 38

According to Rule 4530, FINRA requires members to report customer complaints involving theft, misappropriations of funds or securities, or forgery within 30 days of the event. Reporting is required whether the member knew of or should have known of the event. Related documentation must be filed by the 15th day of the month following the calendar quarter in which the complaint was received. Filings received after 30 calendar days will appear as late on the firm’s 4530 Disclosure Timeliness Report Card.

FINRA Rule 4530 reporting requirements also apply to any violations of securities, insurance, commodities, financial or investment-related laws, rules, regulations or standards of conduct of any regulatory body or self-regulatory organization.

Members must report if an associated person has been suspended, terminated, or has had compensation or any other remuneration in excess of $2,500 withheld, has had fines imposed in excess of $2,500 or is otherwise disciplined in any manner that would significantly limit the individual’s activities, either temporarily or permanently.

Finally, members are required to promptly file copies of documents related to reportable events with FINRA. This may be done electronically. Filings may be edited or amended for 30 days after submission.

Question 39

Mediation

Answer 39

Mediation, in contrast to arbitration, is voluntary and informal. A trained mediator, who is an impartial party, acts as a facilitator between the disputing parties to help them find a mutually acceptable solution. It can be initiated at any time before, during or after arbitration. Any party may withdraw from the mediation process prior to the execution of a written settlement by providing written notice to the mediator, the other parties and the Director. Unlike arbitration, mediation does not impose a solution. It is not binding until the parties reach and sign a settlement agreement.

Question 40

Securities Act of 1934

Answer 40

The term “manipulative, deceptive, or other fraudulent device or contrivance,” as used in the Act, is hereby defined to include

-Any act which operates or would operate as a fraud or deceit upon any person;
-Any untrue statement of a material fact and any omission of a material fact necessary for the investor to have known in order for them to make a reasonable decision; or
-Any manipulative acts that are misleading or deceptive, including churning, which is excessive trading in time or frequency with the sole purpose of generating commissions.

Violations of the Securities Exchange Act of 1934 or SEC rules and regulations, including the use of false or misleading statements, are subject to criminal penalties. The maximum fine for any person is $1 million, imprisonment for 10 years, or both. A maximum fine of $2.5 million can be imposed on a business entity. If violators can prove they were unaware of the rule or regulation, the fine can be imposed, but the violator cannot be imprisoned.

The 1934 Act mandates that all publicly held companies, broker/dealers engaging in interstate business, national securities exchanges and FINRA must file an annual report to the SEC.

The 1934 Act also defines secondary market participants. A broker is defined as any individual, corporation or other legal entity engaged in transacting securities business for the account of others. When acting in the capacity of a broker, the firm is acting as a middle man and charges a commission.

A dealer is defined as any individual, corporation or other legal entity that performs securities transactions for its own account as a part of regular business. When acting in the capacity of a dealer, the firm is acting on its own behalf and selling out of inventory.

Question 41

Maloney Act of 1938

Answer 41

In 1939, a proposal was submitted to the SEC for the registration of a national securities association. The registration statements were approved and the National Association of Securities Dealers - NASD was formed (now Financial Industry Regulatory Authority - FINRA). The Maloney Act provides that the SEC can review FINRA disciplinary actions, disapprove rulings and suspend or revoke FINRA registration for failure to comply with its rules.

Question 42

Trust Indenture Act of 1939

Answer 42

Every corporate bond of more than $5 million and 5 years maturity or longer must have a trust document stating whether the bond is secured or unsecured. If secured, the trust indenture must specify the kind of property and whether the indenture is open-end or closed-end. The trust indenture lists the covenants or promises that the issuer has made to a trustee for the protections and benefit of the bondholders.

Question 43

Investment Advisers Act of 1940

Answer 43

The Investment Advisers Act of 1940 was established to regulate investment advisory activities and define requirements for registration. Investment advisers for an investment company registered under the Investment Company Act of 1940 are considered federal covered advisers required to register with the SEC.

Under the Investment Advisers Act of 1940, an investment adviser is a firm that is paid a fee to advise others, either directly or indirectly, as to the advisability and merit of purchasing or selling securities. Also included in the definition is any firm that, in the regular course of business, issues reports or analyses concerning securities, and charges for such information.

Financial planners and those providing financially related services are defined as investment advisers if they do any of the following:

-Provide advice, analysis or reports concerning securities;
-Provide these services as a regular course of their business; and
-Receive compensation for those services.

The definition of investment adviser does not include the following:
-Banks, savings institutions, or trust companies;
-Broker/dealers or their agents whose advice is incidental to their normal business practice and who receive no special compensation for this advice;
-Employees of investment advisers who are registered as investment adviser representatives;
-Publishers, their employees, and columnists of newspapers, magazines, or business periodicals but only if the advice is not tailored to the individual needs of a specific client or being used to promote particular securities;
-Any person so designated by the state administrator or exempted by the SEC; or
-Professionals, such as lawyers, accountants, teachers, and engineers, whose investment advice is an incidental portion of their business practice. One way to remember this exemption is to remember the word “LATE,” which is an acronym for Lawyers, Accountants, Teachers and Engineers.

Question 44

Investment advisor applications

Answer 44

An investment adviser must register by filing an application for registration with the SEC. The application must include the following:

-The name and form of organization under which the investment adviser engages or intends to engage in business;
-The name of the state where the investment adviser is organized and the location the principal business office and branch offices, if any;
-The names and addresses of its partners, officers, directors and persons performing similar functions
-The education, the business affiliations for the past 10 years, and the present business affiliations of the investment adviser and its partners, officers, directors and persons performing similar functions and of any controlling persons;
-The nature of the business of the adviser, including the manner of giving advice and rendering analyses or reports;
-A balance sheet certified by an independent public accountant and other financial statements;
The nature and scope of the authority of the investment adviser with respect to client’s funds and accounts;
-The basis or bases upon which such investment adviser is compensated;
-Whether the adviser or any of its associated persons are subject to any disqualification which would be a basis for denial, suspension, or revocation of registration under the Investment Advisers Act of 1940; and
-Whether the principal business of the investment adviser is to consist of acting as investment adviser or the rendering of investment supervisory services.

Question 45

State registration

Answer 45

Investment advisers and their employees, except those who perform only clerical functions, are required to be registered in any state in which they do business. Advisers with assets under management (AUM) between $100 million and $110 million may register with the state administrator or the SEC. Advisers with AUM greater than $110 million are required to register with the SEC, and are known as federally registered advisers. Advisers with AUM of less than $100 million are required to register only at the state level.

Investment advisers with no place of business in a particular state, or whose only clients are institutional accounts, are exempt from registration.

Question 46

Soft-dollar arrangements

Answer 46

In a soft-dollar arrangement, a mutual fund manager directs buy and sell transactions to a broker/dealer, for the which the broker/dealer receives commissions. In exchange, the broker/dealer provides research and brokerage services. In contrast, a hard dollar arrangement would involve paying for these same services in cash.

A soft-dollar arrangement encourages mutual fund managers to form an alliance with specific broker/dealers. However, a possible conflict of interest exists because the manager may direct business to a broker/dealer simply because of the alliance regardless of the quality of transaction execution. Therefore, the investment adviser must regularly review its soft dollar relationships for any conflicts of interest.

In addition, there are restrictions on the broker/dealer’s soft dollar expenditures provided to the investment adviser. Soft dollars may only be spent on items which directly benefit investment adviser customers. Examples include securities research, subscriptions to research or other securities publications, applicable software, and educational seminar fees. Disqualified items include new office furniture or computers for the investment adviser’s office, additional personnel, and travel expenses to educational seminars.

Question 47

Penny stock rule

Answer 47

The Penny Stock Rule applies to any offering or sale of non-Nasdaq OTC securities priced at $5 bid or lower. These equities are quoted only in the “Pink Sheets.” Because these securities are highly speculative, penny stock sales require use of strict customer suitability determination and risk understanding prior to the placement of a buy order. In addition, the firm must not only discuss the compensation the firm received but also the compensation the individual representative received. (SEC Rule 15c2-6, and Rule 15g-4)

Regarding penny stocks and their suitability requirements, a formal Suitability Statement must be furnished to the customer before any transactions are made. The customer must then complete the form and return it to the firm, and the broker/dealer must indicate why it concluded that the customer is suitable to buy these securities.

The customer is required to sign the suitability statement until they become an established customer. Please note that the broker/dealer is required to send out the Disclosure Document whether or not the customer is established.

An experienced, or established, customer is defined as a customer who has established and funded an account with the broker/dealer for more than year. The definition also includes a customer who has done three trades on three different days in three different penny stocks with the broker/dealer.

There are several exemptions from the Penny Stock Rule. It does not apply to accredited investors. Also, it does not apply to unsolicited trade instructions received from a customer. It does not apply to transactions where the mark-up in the security has not exceeded 5% for 3 months. Finally, it does not apply to securities in which the broker/dealer has not made a market for 12 months. (Rule 15g-1)

Question 48

Anti-Money Laundering

Answer 48

In quick response to the terrorist attacks on September 11, 2001, Congress passed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (USA PATRIOT Act), a controversial piece of legislation that enabled a sweeping review of homeland security; addressing several social, economic and global initiatives to fight and prevent terrorist activities.

Since the USA PATRIOT Act’s enactment on October 26, 2001, the Financial Crime Enforcement Network (FinCEN) has required banks, broker/dealers and several other financial institutions to establish new anti-money laundering (AML) standards.

To secure the goals of the Act, FinCEN has implemented an AML Program that requires the monitoring of all financial transactions and reporting of any suspicious activity to the government, along with prohibiting correspondent accounts with foreign shell banks. A comprehensive customer identification and verification procedure is also to be set in place. To comply, firms are required to:
-Establish policies, procedures and internal controls based on an in-house risk assessment;
-Appoint a qualified AML compliance officer responsible for administering the AML program and ensuring all employees are aware of their duties;
Provide continual training for applicable employees, producers and other; and
-Schedule independent testing of the program on a regular basis.
-Each member must develop and implement a written anti-money laundering program designed to achieve and monitor the member’s compliance with the requirements of the Bank Secrecy Act. Each member organization’s anti-money-laundering program must be approved, in writing, by a member of senior management.

Question 49

PATRIOT Act (SARs)

Answer 49

Successful Customer Identification Programs (CIPs) are required under the PATRIOT Act. As standard procedures, firms must require complete and truthful information for authentication of all customer identities. Minimum information that must be collected before account opening is:

-Name;
-Address;
-Date of birth;
-Location of birth; and
-Social security number.
-Broker/dealers must make and maintain records of information relating to identity verification. -They must determine whether a customer appears on any U.S. Treasury list of known or suspected terrorist organizations designated by Treasury, and also provide each customer with adequate notice, prior to opening an account, that information is being requested to verify the customer’s identity.

The Customer Due Diligence Rule (CDD Final Rule), outlines and strengthens the due diligence requirements for financial institutions. It also adds a new requirement for financial institutions to identify and verify the identity of the beneficial owners of legal entity customers who own, control and profit from companies when those companies open accounts. This rule was issued by FinCEN, the Financial Crimes Enforcement Network, a government bureau of the U.S. Treasury Department that oversees and implements policies to detect and prevent money laundering. Under the CDD Rule, financial institutions must establish and maintain written policies and procedures that are designed to

Identify and verify the identity of customers;
Identify and verify the identity of the beneficial owners of companies opening accounts;
Understand the nature and purpose of customer relationships to develop customer risk profiles; and
Conduct ongoing monitoring to identify and report suspicious transactions to maintain and update customer information.
According to the new requirement to obtain beneficial ownership information, financial institutions must identify and verify the identity of any individual who owns 25% or more of a legal entity, and an individual who controls the legal entity.

AML training of internal employees may be done in-house directly by a compliance committee, or may be obtained from a competent third party educator outside of the company, provided the training is verified by the employer.

Failure to comply with the guidelines set forth by the U.S. PATRIOT Act may result in severe fines and penalties.

Under the Money Laundering Act, all broker/dealers are required to file Suspicious Activity Reports (SARs) to identify and describe suspicious transactions.

SAR rules state that procedures and plans must be in place to identify activity that one would deem suspicious of money laundering, terrorist financing and/or other illegal activities. Deposits, withdrawals, transfers, or any other business deals involving $5,000 or more are required to be reported if the financial company or insurer “knows, suspects, or has reason to suspect” that the transaction:

-Has no business or lawful purpose;
-Is obtained to exaggerate other reporting constraints;
-Uses the financial institution or insurer to assist in criminal activity;
-Is obtained using fraudulent funds from illegal activities; or
-Is intended to mask funds from other illegal activities.

Some “red flags” to look for in suspicious activity:
-Customer uses fake ID;
-Two or more customers use similar IDs;
-Customer changes a transaction after learning that they must show ID;
-Customer conducts transactions so that they fall just below amounts that require reporting or record keeping;
-Two or more customers, trying to evade BSA requirements, seem to be working together to break one transaction into two or more transactions;
-Customer, trying to evade BSA requirements, uses two or more locations or cashiers on the same day to break one transaction into smaller transactions; or
-When opening the account, the customer is not concerned about the services provided, cost of services, or the securities to be invested in, but is very interested in the firm’s AML program.

Relevant SARs must be filed with FinCEN within 30 days of initial discovery. Reporting takes place on FinCEN Form 108.

Question 50

Know Your Customer (KYC)

Answer 50

FINRA requires member firms and their associated persons to abide by the Know Your Customer (KYC) Rule while opening and servicing their accounts. This involves gathering information about customers by asking specific questions. Many of the questions are related to suitability, including those focusing on investment objectives, experience, and time horizon, as well as age, financial situation, other investments, tax status, liquidity needs and risk tolerance.

Additional required disclosures include information about domestic or foreign residency and/or citizenship, corporate insiders, employees of broker/dealers or self-regulatory organizations (SROs).

The SEC also requires firms to attempt to obtain a customer’s name, tax identification number, address, telephone number, date of birth, employment status, annual income, net worth (excluding primary residence), and investment objectives regarding certain accounts.

Firms are required to put procedures in place to verify the identity of any person seeking to open an account. Before opening an account, a firm must obtain, at a minimum, the name, date of birth, address and identification number (for example, a social security number) of a customer.

Question 51

Bank Secrecy Act (CTRs)

Answer 51

The Bank Secrecy Act (BSA) was designed to help identify the source, volume, and movement of currency transported into or out of the United States, or deposited in financial institutions. The BSA authorizes the U.S. Department of the Treasury to require financial institutions to maintain records of financial transactions and to report any suspicious transactions. The Financial Crime Enforcement Network (FinCEN) enforces the BSA.

For wire transmittals of funds in excess of $3,000, broker/dealers must obtain and keep specified information about the transmitter and the recipient of those funds. This information must also be included on the actual transmittal order. For transmittal of funds in excess of $10,000, financial institutions must verify the identity of persons conducting the transaction.

Broker/dealers are required to file a Currency Transaction Report (CTR) for single transactions involving currency that exceed $10,000, or multiple transactions during any one business day that total more than $10,000. CTRs must be filed with the Financial Crimes Enforcement Network (FinCEN) with the Bureau of the U.S. Treasury within 15 days. Records of these reports must be kept for 5 years.

Transactions that are generally seen as susceptible to laundering or manipulation include, but are not limited to payments, rollovers, loans, transfers, partial withdrawals, surrenders, and death claims.

Question 52

Regulation S-P Customer Privacy

Answer 52

• Broker/dealers must implement privacy policies to protect consumer nonpublic personal information, also known as personally identifiable information (PII).
• Consumers must be provided with an initial privacy notice, and those who become customers must receive annual privacy notices that detail a broker/dealer’s information-sharing policies and inform customers of their rights.
• Broker/dealers must establish safeguards to ensure that customer records and information are secure, confidential, and protected from unauthorized access or use.
• A broker/dealer cannot share a customer’s nonpublic personal information with nonaffiliated third parties, unless:
  • The institution (such as a joint marketer or service provider) provides certain information to the customer; and
  • The customer has not elected to opt out of the information-sharing program.

Customers must be given a reasonable means and a reasonable way and amount of time to opt out of sharing with nonaffiliated third parties. A reasonable means may include a response link in an email, a prepaid postcard addressed to the broker/dealer, or a toll-free phone number. However, it would not be reasonable to require the customer to write a letter or fill out a form to opt out.

For the purposes of Regulation S-P:
- A consumer is an individual who obtains products or services from a financial institution, but who usually has no contact with that institution beyond the one-time delivery of products or services to be used for personal or family purposes. The consumer only needs to receive the privacy notice at the time that the service or transaction is performed.

A customer is an individual or entity with which a financial institution expects to have a continuing relationship.

Question 53

Telephone Consumer Protection Act

Answer 53

As defined by the Telephone Consumer Protection Act (TCPA) of 1991, telemarketing (telephone solicitation) is a telephone call or message directed toward an individual with whom the marketing organization has no relationship, for the purpose of encouraging the purchase or rental of, or investment in property, goods or services. In addition, telemarketing calls may be initiated when a telemarketer has established a business or personal relationship with another person, or received a consumer’s prior express consent in writing.

The following are communication restrictions:

Time of Day Restriction — No private residence can be contacted before 8 a.m. or after 9 p.m. (the call recipient’s time), unless specific arrangements were made with the called party.
Firm-Specific and National Do-Not-Call lists — Any persons that have stated that they do not wish to receive outbound telephone calls made by or on behalf of the member, or have registered their phone number on the Federal Trade Commission’s national do-not-call registry may not be contacted.
Telemarketers must always identify their name, name of the person or entity on whose behalf the call is being made, and the telephone number or address at which the person or entity can be contacted.

These telemarketing regulations also apply to fax transmissions.

Question 54

Insider Trading Act of 1988

Answer 54

Insider trading, which is the use of information that is unavailable to the general public (nonpublic information) for the purposes of manipulating or exploiting a market opportunity, is prohibited by law. Investment advisers, broker/dealers and their representatives must not participate in any form of insider trading.

Any person who purchases or sells securities while in the possession of material nonpublic information, or communicates such information to another person, is in violation of The Insider Trading Sanctions Act of 1984 and Insider Trading and Securities Fraud Enforcement Act of 1988.

The SEC can bring civil action against any such person in a federal court. Charges can also be brought against any person who directly or indirectly controls such a person. In other words, supervisors may also be charged if the persons they supervise violate this Act.

Civil penalties for insider trading violations are determined by the court, and vary according to the circumstances. The maximum civil penalty is three times the profit gained or the loss avoided from the use of the information. This is also known as treble damages.

Criminal penalties for insider trading violations are more severe. The court will determine the penalty that will be imposed on any person who, at the time of the violation, directly or indirectly controlled the person who committed the insider trading violation. Penalties may include fines, expulsion, and incarceration. The monetary penalty may be up to $5 million for individuals, and up to $25 million for corporations. The prison sentence for individuals may be up to 20 years.

The Securities Exchange Act of 1934 defines an insider as a director, officer, or owner of 10% or more of the stock of a corporation. Persons who become insiders are required to notify the SEC within 10 days of becoming an insider. Insiders are also required to report changes in their positions within 2 days of the change.

Insiders are prohibited from acting on material nonpublic information for their own profit. This rule also applies to any employees or personnel who may have access to inside information. Any information must be made public via a press release and disseminated through a wide medium and the appropriate document must be on file with the SEC before anyone can act on the information.

Short-swing profits result from trades or sales of securities held by a company insider for less than 6 months. The Securities Exchange Act of 1934 defines insiders as officers, directors and owners of 10% or more of the outstanding shares of any class of securities. These profits must be paid back to the corporation. However, the insider remains responsible for taxes owed on the profit. If this happens, this is called a disgorgement, and the insider must provide the profit to the corporation; however, the insider is still required to pay taxes on the profit.

The Securities and Exchange Act of 1934 requires that broker/dealers establish, maintain, and enforce written policies to prevent the misuse of nonpublic information by any person associated with the firm. This includes the establishment of what are known as Chinese walls. These are internal procedures that limit and control the passing of potentially sensitive, nonpublic information between the departments of a firm. In addition to the 1934 Act, there is also the Insider Trading and Securities Fraud Enforcement Act of 1988, which provides further clarification on the penalties for violating insider trading rules.

Question 55

Business Continuity

Answer 55

Firms are required to have a business continuity plan that includes disaster recovery. The concept is that since firms are responsible for customer records, assets and regulatory reporting, they must have plans in place in case disaster strikes. These plans must be updated annually and approved by senior management.

Additionally, each firm must have contact information for at least two principals available on their website. This contact information must also be available to the regulatory authorities. These contact persons serve as firm spokespersons in case of disaster.

The disaster recovery plan must provide for backup documentation and storage location. The plan must also address how trading continues if the firm is shut down due to natural or manmade disaster. Typically, firms store their documents and have a backup trading facility at another location to increase the chance of uninterrupted operation in the event of disaster.

Question 56

NYSE rules

Answer 56

NYSE rules are generally stricter than FINRA rules. For example, in cases involving a representative with outside employment, or a representative with dual registration or opening an account at another firm, FINRA requires disclosure and duplicate confirmations, whereas NYSE mandates the permission of the employing member. Otherwise, NYSE and FINRA rules are very similar, if not identical. Both treat advertising more seriously than sales literature. The reason is obvious: advertising is mass-media (television and Internet) and is therefore untargeted. Sales literature is targeted, directed toward existing clients or their friends and relatives. For example, Internet advertising goes out to anyone accessing the site, whereas e-mail is targeted.

New York Stock Exchange member firms that provide research must ensure that their research is either written or approved by a Supervisory Analyst, Series 16.

Under New York Stock Exchange rules, the approval of a new account is done by a partner or a principal of the firm. Also, the registered rep is responsible for keeping track of the customer’s positions in the securities whether the customer is long or short. Additionally, the registered rep must keep customers positions records by individual security.

Member firms are permitted to hold customer mail, such as trade confirmations and account statements, if the firm receives a prior written request from the customer.

NYSE member firms must maintain a central file of written and oral customer complaints. Resolution of these complaints must be monitored by a Series 14 qualified principal. Although copies of the complaints are often held at the office where received, the New York Stock Exchange requires all complaints, written and oral, be placed in the central file at the home office. Resolution of these complaints must be supervised by a compliance professional who is qualified under Series 14.

Upon employment with an NYSE member firm, an associated person falls under the NYSE constitution and rules. Associated persons with New York Stock Exchange member firms have an apprenticeship period of 120 days, or four months, in which they are not allowed to communicate with the public.

An employee of an NYSE and FINRA member must receive written permission to open a securities account at another broker/dealer. Duplicate trade confirmations must be sent to the employing member firm.

Investment advisers, adviser representatives, broker/dealers, agents, and registered representatives, are all prohibited from front-running their clients’ orders, a practice where a securities professional executes personal or firm trades prior to the client’s trade. It is a violation of SEC rules for members and associated persons to use material nonpublic information to trade ahead of block trades and customer orders. A block trade is generally a transaction involving 10,000 shares of a security or securities with a market value of $200,000 or more.

Furthermore, investment advisers, broker/dealers, and their associated persons must not “shadow” client accounts, a practice where the investment adviser copies the trades in the client’s account.

Question 57

NYSE - Part II